If you’ve recently been planning to refinance your mortgage, you must know when it’s the most economical to do so and when it’s the smartest financial move. Follow this definitive guide to know when to refinance a mortgage and other critical details of mortgage refinancing.
The monthly mortgage payments usually make up the largest expense on your monthly list of financial expenditures. Although these are times of inflation and interest rates are rising, you still might be able to lower your interest rate or pay off your loan quickly if you consider refinancing. Refinancing can save you a lot of money if done in the right way and at the right time. However, refinancing doesn’t make sense if done without any knowledge or at the wrong time. If so, it can cost you money instead of letting you save it.
So, the most important question here is when to refinance a mortgage. Because refinancing isn’t always the best financial move, you need to carefully consider all your situations and do the math so that refinancing can result in saving money and not the opposite.
Refinancing your mortgage now when interest rates are soaring high might only make sense if you want to add or remove a borrower from your loan, switch from ARM or adjustable interest rate to fixed rate, or switch to a longer loan term by reducing the monthly payments. So, refinancing is only a good idea if it will save you money or make it easier for you to pay your monthly bills.
The process to refinance your mortgage can be tiring and costly, but if done at the right time with the right conditions, it can be worth it in the longer run. Before going for refinancing right away, you need to make sure that you are doing so for the right reasons and that the outcome will be equivalent to your expectations. This article will explain all the good reasons and times when refinancing your mortgage can be the best financial move and can save you tons of money. You’ll get to know when to refinance your mortgage to get the best returns. So without further redo, let’s start.
What is mortgage refinancing?
Before diving into the details of when is the right time to refinance a mortgage, here’s a reminder for some of the basic concepts of mortgage refinancing. The term loan refinancing or simply refinancing refers to the process of swapping out your existing loan with a new one that has better loan terms and conditions.
When taking out a new loan, borrowers usually prefer a different lender or bank than that of the previous loan in order to have lower loan fees and reduced expenses. Because refinancing wouldn’t just make sense if you take out a new loan from the same lender you took out the initial loan from. People consider refinancing to make their loan conditions better rather than keeping them the same. Talking about mortgage refinancing, it is when individuals take out a new home loan to replace their existing one.
Usually, people refinance loans to get rid of initial loans that are not very economical or cost-effective. We’ve just touched on the basics of refinancing, you can better understand the detailed concept of refinancing your loans through a detailed guide here.
How does mortgage refinancing work?
When you refinance, you get a new mortgage with better terms and it also helps you in paying off the initial mortgage. Refinancing is just like getting a mortgage loan to buy a house. But the difference is that you’ll be paying off your initial loan with the new loan and then continue paying off the new one. Individuals opt for more budget-friendly options when getting a new loan to replace the existing one. Because of the lower interest rate on the new loan, you can save hundreds or even thousands in total interest over the life of the loan.
Refinancing is the best financial move when the interest rates have dropped. At such times, many homeowners want to refinance their mortgage by getting a new one with lower interest rates. These are the times when lenders get busy and refinancing can take longer. In the case of a loan backed by the FHA or the Department of Veterans Affairs (VA), refinancing can take longer than usual.
While refinancing, your previous loan or mortgage is paid off either directly by the new lender/bank or you are financed the amount to pay off the previous loan. Now, the previous loan has been paid off completely and you need to pay off the new refinanced loan which is much more budget-friendly and economical for you.
Is refinancing a mortgage a wise choice?
With interest rates on the rise, refinancing now might not be the wise choice for many homeowners. But the math isn’t simply limited to comparing interest rates of the time you took out the initial loan and the current interest rates. There are many other things or factors that need to be considered before going for refinancing a mortgage.
According to Bill Pecker, the executive vice president and chief operating officer of mortgage lender American Financial Resources, there are three things that you need to take into account before making an important decision.
- Old monthly payments versus new monthly payments (excluding any taxes)
- The expense or cost of getting a new mortgage
- The amount of time that you intend to be in the home
Once these three things are known and clear, you can go ahead and calculate your return. If it comes out positive and you think refinancing can save you big, you’re good to go with refinancing your mortgage to get a new one. Generally, mortgage refinancing is only worth it when it makes sense for your finances. If it helps you free up or save money in your monthly budget or reduces the overall cost of the loan, refinancing to a new mortgage is well worth the money and effort.
But it also depends on your financial goals; whether you’re looking for lower monthly payments or you want to cut down on the total interest paid during the loan’s lifetime. Whatever your financial goal, if refinancing can help you get to it, then it’s definitely worth it.
When to refinance mortgage?
Getting a new loan through refinancing might not be as easy and inexpensive as you think. Since mortgage refinancing can cost almost 2% to 6% of the loan’s principal, it is important for homeowners to carefully consider and determine whether refinancing is a wise financial decision. The closing costs that come with refinancing can include appraisal fee, credit report fee, origination fee, and title insurance fee. All-inclusive, refinancing can be costly so it’s best to consider all your situations and factors and determine the possible outcome before making the big move.
If refinancing can save you money, help you build equity, or pay off your mortgage faster, refinancing is probably a good idea in such cases. Refinancing is best if you can lower your interest rate or plan to live in your house long enough to recoup the closing costs. The question of when to refinance a mortgage is not just about comparing interest rates on your timeline. It is also about your credit score and history being good enough to qualify for the new mortgage.
Those with the best credit get to have the best terms and rates. Before refinancing, it’s important to check your credit score in order to have a solid understanding of your risk profile. If your credit score doesn’t look good due to carrying a high credit card balance or being late on your monthly payments, you might look like a riskier borrower and your chances of getting a new loan through refinancing might become less.
Here are six times when refinancing your mortgage can prove to be economical and budget-friendly for you.
- When you want to lock in a lower interest rate
- When your credit has improved
- When you want to shorten your mortgage term
- When you want to shift from adjustable rate (ARM) to fixed interest rate
- When you can tap into your home equity
- When you want to get rid of mortgage insurance
You want to lock in a lower interest rate
So the first thing that comes to mind when we hear about refinancing is lowered interest rates because that’s probably the most basic reason why people choose to refinance their mortgages. If interest rates have lowered since you took out your initial mortgage, you can think of refinancing it with a new mortgage to avail of those lowered rates. However, owing to the soaring interest rates due to the ongoing inflation, refinancing might not be a good choice at this moment if the lowered interest rate is the sole purpose of it.
During the pandemic, the interest rates were at their historic lows so a lot of people refinanced their mortgages. Refinancing from a high rate can help you save a lot on your monthly payments. Furthermore, mortgage rates can fluctuate since they’re affected by a variety of factors including market movements, inflation, the economy, other global factors, etc. So if these factors end up lowering the mortgage rates, you might be able to secure a lower interest rate than you have on your existing mortgage.
If you’re thinking about how much should mortgage rates fall to make refinancing worth it, a traditional rule of thumb is to consider refinancing if the interest rate has fallen by one or two percent. Whatever the rates, you need to make sure that the math works out in your favor. You can use a mortgage calculator to keep track of some of the mortgage costs.
A lowered interest rate can not only help you save money, but it can also increase the rate at which you build equity in your house. Furthermore, you’ll also get to have budget-friendly monthly payments to pay off.
Your credit score and history have improved
Nowadays, when interest rates have increased more than ever, your only chance of getting a lowered interest rate lies in having an improved or excellent credit score. The credit score is an important factor and can affect a lot when determining your interest rate. In general, the better your credit score, the lower the interest rate you’ll get.
So if your credit score has improved since getting your initial mortgage, there are high chances of you getting a lower interest rate on the new mortgage. For that purpose, it’s important to work on building up an excellent credit score if you wish to save money on mortgages by lowering your interest rate. Make sure you haven’t missed any monthly payments on the previous mortgage, are paying the monthly installments on time, and are making at least the minimum credit card payments. Such efforts can reflect in your credit history, making the lenders or banks put in lower interest rates for you.
You want to shorten your mortgage term
Refinancing might be the best option if you wish to pay off your mortgage early. Refinancing into a mortgage with a shorter term can help you get out of your mortgage quickly. It’s nothing new that mortgages can be life-long and sometimes stressful for your financial life. For that reason, sometimes people might want to pay their mortgage as quickly as possible. And refinancing can help with that.
Suppose you started off with a 30-year term for your mortgage and are five years into it, so that means you have 25 years left until you pay off your mortgage completely. If you refinance into a 15-year mortgage, you’ll be able to shave 10 years off your mortgage. Even though your monthly payment will increase after refinancing into a shorter-term loan, you will be able to cut down on the total interest paid over the total span of the loan. The interest savings from a shorter-term loan can be especially beneficial for your financial life. You can use this saved amount to pay off other smaller loans.
You want to shift from an adjustable rate (ARM) to a fixed-rate mortgage
Suppose your initial mortgage was an ARM or an adjustable rate mortgage that keeps your interest rate fixed for the first few years and then changes it periodically. If your mortgage rates are increasing, an adjustable-rate mortgage might turn out to be expensive. Refinancing into a fixed-rate mortgage can help you overcome those expenses.
Since an ARM can increase your interest rate beyond what you’ll pay with a fixed-rate mortgage, refinancing to shift to a fixed-rate mortgage is beneficial in the long run. Moreover, if the intro rate period of your ARM is ending soon, you need to consider refinancing as your next financial step.
When you’re taking out your first mortgage, ARMs might seem attractive at that time since they start off with lower interest rates as compared to fixed-rate mortgages. However, as the intro rate period passes and the interest rate starts changing periodically, especially at times of inflation like nowadays, you realize ARM might not be the most economical choice. And if you are worried about your monthly payments going up and future interest rate hikes, you can consider refinancing into a fixed-rate mortgage for some peace of mind.
You want to tap into your home equity
If your home’s value has increased since you bought it, refinancing can prove to be somewhat beneficial, especially if you have another big debt to pay off or you want to fulfill any financial goal. You can go for a cash-out refinance which allows you to take out a loan bigger than the original loan or the amount you still owe and in return, you receive the difference in cash that specifies your home’s gained value.
Homeowners often use this method to cover other major expenses, like financing a child’s education, paying off a high-interest, repairing or remodeling the house or any other financial goal that adds value to their home or quality of life overall. You wouldn’t want to use cash-out refinance for insignificant expenses. Cash-out refinance comes with a fee, so make sure the expenses that you’re using the refinance money on are worth the cost.
Although there are no legal restrictions on how to spend the cash-out refinance cash, make sure you use it to get over a big financial hurdle in order to have a smooth financial journey ahead. Ultimately, your actions and how you use the money will decide whether refinancing is worth the money and effort or not.
You want to get rid of mortgage insurance
If you have an FHA mortgage, you are probably paying a big amount in mortgage insurance despite having more than 20% equity in your house. FHA loans are known for mortgage insurance premiums (MIPs) that can cost homeowners up to thousands of dollars every year for the loan’s entire life. If you want to get rid of such MIPs, refinancing to a conventional loan can help.
When you sign up for a conventional mortgage, you will have to pay private mortgage insurance until you reach 20% equity for your house and you can ask your lender to cancel it. Otherwise, it will automatically be canceled after you reach 22% equity.
Refinancing can be a great and smart financial move if it helps you free up money in your budget by reducing your mortgage payment, shortening the term of your loan, or helping you build equity more quickly. If done carefully, refinancing can prove to be a valuable and economical tool for bringing debt under control and tapping into more budget-friendly options.
However, before you dive deep into refinancing, make sure to complete the first and most essential step which is to ask yourself whether refinancing can be practically helpful and in what ways. You need to carefully assess your every situation and the overall financial impact that refinancing could probably have. It is indeed a big financial step, so make sure to do the math before starting off.
Just like applying for your initial mortgage, refinancing can take significant time and effort in understanding your options better. You might be needing additional paperwork, so do consider whether the savings will make up for this extra effort or not before starting the process. Also, be wary of your credit’s shape since it can affect a lot on the interest rate you’ll be getting. Take the next steps only if your credit score is in great standing.
Again, remember that refinancing is an expensive process, costing up to 2% to 6% of the loan’s principal. So, if you aren’t staying in the house for a long time, the cost of refinancing may negate any of the possible savings. Remember that a smart homeowner is always on the lookout for ways to reduce debt, save money, build equity and eliminate their mortgage payment. If neither for any of these reasons, refinancing might just not make any sense.
All in all, this article has taken an in-depth look at when to refinance a mortgage, covering all the times refinancing makes sense and can save you money or fulfill the reason you’ve chosen to take this financial step. If you’ve read this guide in detail, you’ll be well aware of identifying your circumstances to find out whether refinancing is a smart financial move for you.